Capital investment analysis is a term used to describe strategies that aid investors in determining if the amount of return connected with a given capital investment is equitable in comparison to expense and risk associated with securing and holding onto that asset. By engaging in this type of analysis, the investor can determine the overall impact of owning the investment on his or her financial portfolio, and decide if the opportunity should be passed over in favor of one that shows promise of providing returns that are more desirable. At the same time, a capital investment analysis and comparison is helpful in evaluating the ongoing performance of assets already found in the portfolio, making it easier to determine if they are still desirable or need to be replaced, based on changes in the level of return or the volatility connected with the asset.
While there are several different ways to approach a capital investment analysis, most will involve beginning with the current value of the investment, and determining the amount of return that can reasonably be anticipated over one or more upcoming accounting periods. Doing so provides a clearer understanding of what type of cash flow is likely to generate from the asset, given current market conditions.
By projecting the rate of return for upcoming periods as part of the capital investment analysis, and allowing for known factors that could influence that rate of return, the investor can make an informed decision regarding what to do with the investment. If there are indications that the return on investment will begin to decline at a specific point in the future, it may be wise to begin developing an exit strategy that would allow the disposal of the asset just prior to that decline. Should the predictions indicate the asset is likely to continue generating returns that are constant or improve over time, and do not involve an increase in the degree of risk, the results of the analysis will indicate that the investment remains a good option and should be held for an extended period of time.
Since a capital investment analysis may involve evaluating the potential of an asset that the investor is considering or an asset already held, making use of this approach should not be seen as a one-time event. Rather, the savvy investor will regularly conduct an analysis on capital investments. This makes is possible to determine if the assets are performing as originally projected, or if the returns have been less than originally thought. When that is the case, the investor will want to identify why the investment is performing at a lower level, and how long those factors are likely to remain an issue. After revising expectations regarding the performance of the asset, the investor can compare those revised projections with the risk and expenses associated with the investment, and make decide what action is likely to be in his or her best interest.
